UK sanctions litigation trends for the financial sector

In the 2023 edition of the Yearbook we noted an uptick in sanctions-related commercial litigation before the English courts. That trend has since continued, and financial institutions have been at the forefront of those disputes as they seek to balance their obligations under the UK sanctions regime with their contractual obligations to clients and counterparties.

Read the 2023 Yearbook here

As the English commercial courts have delivered more judgments in international sanctions disputes, various themes have emerged. Broadly, these demonstrate that the English courts:

are prepared to expedite the case management and hearing of sanctions-related cases, to minimise the prejudice to innocent parties caused by the state of affairs and to provide certainty to all affected parties;
try to reach commercial outcomes, for example, to uphold payment obligations affected by sanctions, provided of course that the payment will not make funds (or “economic resources“) available to a sanctioned entity during the currency of the sanctions regime, and provided further that the proposed method of performance is in accordance with the terms of the contract; and
place no or low weight on submissions as to the prejudice that will or may be caused to a sanctioned party, in circumstances where the prejudice is principally caused by the imposition of the sanctions regime and not the judgment per se.

This nonetheless remains a developing area, and several judgments have recently been overturned on appeal as the courts seek to develop a clear and consistent body of precedent to guide affected parties. We explore some of the key recent case law below.

The period 2020 to 2023 has seen a dramatic increase in commercial international sanctions disputes in the High Court:

Source of data: Solomonic Year in Review 2023, p20

What are the UK’s Russia Sanctions?

The UK Government has described the sanctions imposed against Russia,¹ following its invasion of Ukraine, as the “most severe package of sanctions ever imposed on a major economy“.² Their core purpose was and is to restrict Russia’s access to global capital and financial markets, thereby undermining its ability to finance the war. Key measures have included:

A prohibition on UK banks processing payments to, via, and from the Russian central bank and other designated banks;
Asset freezes targeted at approximately 2,000 designated persons (including entities) connected with Russia, which have resulted in over £22 billion of Russian assets being frozen;³ and
Internationally coordinated sanctions by the UK, EU, US and other partners freezing approximately €300 billion of Russia’s central bank foreign reserves.⁴

For over two years, UK banks have had to grapple with issues arising from the implementation and expansion of these sanctions. These are very serious matters and the consequences of even a minor or inadvertent breach may include monetary penalties and adverse publicity.

How are the UK’s Russia sanctions implemented?

In 2014, the EU (including the UK) and its international partners imposed sanctions against Russia following the annexation of Crimea. This cooperation has continued post-Brexit. The UK’s domestic sanctions regimes, including the relevant Russia (Sanctions) (EU Exit) Regulations 2019, sit within a post-Brexit legislative framework established by the Sanctions and Anti-Money Laundering Act 2018 (“SAMLA“). In response to Russia’s full-scale invasion of Ukraine in February 2022, the UK imposed additional financial, trade, aircraft, shipping and immigration sanctions on designated persons (including individuals and entities) and specified ships connected with Russia.

What scenarios have arisen so far?

The UK’s sanctions regime can make performance of a contract extremely difficult, unlawful or impossible. Faced with a choice between breach of sanctions and breach of contract, parties have looked to the English courts to endorse pragmatic (and, crucially, legal) solutions.

1. Do sanctions apply in the first place?

The threshold question will often be whether sanctions apply at all. As explored further below, the question may arise where the parties’ competing positions are aligned with their preferred commercial or strategic interests.

The case of Celestial Aviation v UniCredit⁵ concerned USD-denominated letters of credit issued by a sanctioned Russian bank to EU-based aircraft lessors, in connection with the leasing of aircraft to Russian companies. The confirming bank under the letters of credit was the UK branch of German bank UniCredit. When approached to make the payments, UniCredit declined to pay the EU beneficiaries, on the basis that such payments were prohibited by sanctions affecting the issuing bank, whilst simultaneously seeking licences from the UK Office of Financial Sanctions Implementation (and equivalent US and EU authorities) to permit the flow of payments. At first instance, the High Court adopted a purposive interpretation of the relevant sanctions legislation, concluding that UniCredit’s obligation to pay the EU entities did not offend sanctions against Russia as it would not make funds available to any designated persons. This finding was unanimously overturned on appeal. Acknowledging the importance of statutory context and purpose, the Court of Appeal instead focused primarily on the broad nature of the actual words used in the regulation, concluding that it was a “blunt instrument” that risked catching arrangements that were not “within the original mischief“. The Court of Appeal stated that the proper solution to such issues could be found in statutory exemptions and the licensing regime. (In fact, a UK OFSI licence was granted in this case during the litigation.) Further, while the High Court had rejected UniCredit’s s 44 SAMLA defence on the basis that its belief about the applicability of sanctions was unreasonable (albeit truly held), the Court of Appeal stated that had it been required to determine the issue it would have found UniCredit’s belief to have been reasonable. The Court of Appeal acknowledged the inherent difficulty in forming a view about new legislation at short notice and emphasised the need to avoid viewing the issue with the benefit of hindsight. The Court of Appeal did not disturb the prior finding that UniCredit was liable to pay interest and costs, on the basis of the gap between it obtaining the relevant licences and making the payments.

In Litasco v Der Mond⁶ the High Court found that the Swiss oil marketing and trading company Litasco was not “owned or controlled directly or indirectly” by a designated person for the purposes of the sanctions regime simply because either: (i) its founder and former president and chief executive was a designated person with a minor shareholding in Litasco; or (ii) President Putin presumably had the means of placing all of Litasco and/or its assets under his de facto control, should he decide to do so. The High Court found that it was not arguable that President Putin was in control of “everything in Russia” for the purposes of interpreting “control” in this context. The High Court distinguished the case of Mints,⁷ where the Court of Appeal was not required to decide the point but did accept that Mr Putin controlled NBT, in circumstances where NBT was controlled and almost wholly owned by the Central Bank of Russia, which was an organ of the Russian state and in practice served as an arm of the executive government. In November 2023, the UK Government released guidance expressly to clarify its approach to ownership and control, consistent with the findings in Litasco: you can read more about this in our briefing here.

2. If so, does the doctrine of foreign illegality apply?

Where sanctions do apply, parties have sought a solution to the breach of contract versus breach of sanctions dilemma in the doctrine of foreign illegality – namely, the principle that an English court will not enforce an obligation which requires a party to do something which is unlawful under the laws of the country in which the act has to be done. However, the courts assess the application of the doctrine with care. In Celestial Aviation v UniCredit, for example, UniCredit alleged that making the payments through a correspondent bank in USD would contravene US sanctions. Both the High Court and the Court of Appeal held that the doctrine of foreign illegality did not assist UniCredit. However, the Court of Appeal did not endorse the High Court’s reasoning to the effect that UniCredit was not relieved from performance as it could perform in another way under the contract (i.e. by making payment in cash or a different currency). Instead, the Court of Appeal found that because UniCredit had framed its application for a US licence in a way that linked payment to the EU beneficiaries under the letters of credit to payment from the issuing Russian bank, it had not made “reasonable efforts” to obtain the relevant licence.

3. Or is it possible for a party to deliver substitute contractual performance?

The question arising in Celestial of whether a substitute form of contractual performance can be rendered which does not fall foul of the sanctions regime is a common one in sanctions-related disputes. The starting point under English law is that a party cannot unilaterally decide to substitute its performance under the contract for something different, even if the substituted performance might seem to be equivalent to or better than what was originally agreed. This starting point is subject to the terms of the contract under consideration; for example, a clearly worded clause could expressly require a party to accept an offer of non-contractual performance of an obligation from the other party in certain circumstances. The English courts have sought to reach commercial outcomes by the application of orthodox legal principles, emphasising that reasonable business people expect predictability and certainty in commercial transactions, as the following cases demonstrate.

In RTI Ltd v MUR Shipping, RTI was effectively unable to pay MUR for shipments of ore in USD (as specified under the contract) due to the impact of US sanctions. RTI offered to perform the contract by paying MUR in euros and covering any costs of MUR converting the payment into USD. MUR declined to accept the non-contractual performance proposed. RTI chartered-in replacement vessels to transport the ore and sought damages for its costs of doing so. The case has a complex procedural history, commencing with arbitration and going all the way to the Supreme Court.⁸ In overview, the Court of Appeal upheld the original arbitral decision and accepted that the usual principles as to substituted performance were not applicable, due to the express terms of the contract, which permitted a party affected by a potential force majeure event to “overcome” the event by using “reasonable endeavours“. The Court of Appeal held that this was precisely what RTI had sought to do, such that the force majeure clause was not invoked, and MUR was not released from its obligations. However, on appeal, the Supreme Court reversed the Court of Appeal decision and upheld the earlier High Court decision, accepting MUR’s argument that “reasonable endeavours” required steps to reasonably be taken to ensure contractual performance (i.e. payment in USD) but did not require the acceptance of an offer of non-contractual performance. The Supreme Court referred to the particular importance of predictability and certainty in English commercial law and expressed concern that permitting non-contractual performance would tend to introduce needless uncertainty.

For more, see our briefing on the Supreme Court’s decision here

In another shipping case, Gravelor Shipping v GTLK,⁹ the High Court noted that clauses intended to address extraneous circumstances which render strict performance impossible, while keeping the substance of the obligations alive, may well involve one party accepting performance that is not “in strict accordance with its terms“. In that case, Gravelor sought to exercise purchase options under the charterparties for two vessels as sanctions against the owner affected Gravelor’s ability to pay hire and continue insurance and maintenance arrangements. The parties’ contract provided that where sanctions affected the processing of payments, the parties had to take “all necessary steps” to resume payments. The High Court was satisfied that the clause extended to requiring the vessel owner, GTLK, to nominate an alternative bank account for the payment, accepting that GTLK would not be able to access the funds until the sanctions were lifted.

Similarly, in the Litasco v Der Mond case referenced above, the High Court held that the force majeure clause which came into operation when performance of an obligation was “delayed, hindered or prevented” was not invoked in circumstances where Der Mond could (subject to having the funds to pay) satisfy its payment obligation by an alternative method. The High Court accepted that the reference to “hindrance” meant the force majeure clause had a relatively broader application than clauses triggered only where performance is “prevented” but stressed that it is performance of the obligation itself which must be hindered and not a particular method of performance where the contract did not require performance by that method. The Court inferred that the real issue (which did not amount to a force majeure event), was Der Mond’s lack of foreign currency to meet its obligations, stemming from difficulties trading Russian oil.

Fortenova Grupa D.D. v LLC Shushary Holding¹⁰ is another example of the English courts being asked to permit an alternative, sanctions-compliant means of fulfilling a contractual right or obligation.¹¹ However, in that case the remedy stemmed from the Court’s equitable jurisdiction, rather than contractual interpretation. EU-based Fortenova sought the redemption of loan notes with a face value of approximately EUR 400 million from a subsidiary of VTB Bank PJSC, a sanctioned Russian bank, in order to complete a proposed refinancing. The High Court noted the unfortunate and paralysing situation Fortenova found itself in by virtue of being unable to exercise its contractual right of redemption, stating that the principles which allow a debtor to rid their property of encumbrances are well established and can include the release of security by payment into court of the redemption amounts. Shushary did not raise any objection in principle and the Court duly granted orders for the redemption monies be paid into court, for Shushary to apply for in the future upon the sanctions being lifted.

The High Court was alive to the potentially damaging consequences of sanctions on innocent parties, describing the potentially “disastrous effects” facing Fortenova if it was not able to complete the refinancing. These included that Fortenova would be unable to repay the notes on their maturity date and release the security, possibly leading to: (i) enforcement action by the other, non-sanctioned noteholders; and (ii) adverse impacts on other finance and credit arrangements, and its business generally, due to an upcoming audit deadline. Furthermore, the High Court declined to order Fortenova to pay default interest under the contract, stating that it would be harsh to require this when Fortenova was at all times willing and able to pay but had been prevented from doing so by sanctions. By comparison, the High Court did not place any weight on submissions to the effect that payment into court would be highly prejudicial to Shushary as it had not identified any suitable alternative way through the impasse.

What scenarios might arise in future?

Litigation may be less likely to arise in circumstances where transacting parties have factored the potential imposition and consequences of sanctions into their contractual framework. By way of example, it has become commonplace for loan finance documentation to include provisions aimed at mitigating the risk of a borrower becoming subject to sanctions. In our experience, such provisions are now relatively standard and rarely the subject of detailed negotiation.

By contrast, a more complex issue can arise where, instead, it is one of the lenders or payment intermediaries (e.g. a facility agent) that becomes the subject of sanctions. In our experience, loan documentation is generally not designed to cater for the range of consequences that may result. Nevertheless, sanctions impose a material risk on large capitalisation cross-border loan transactions, which commonly feature a wide and frequently changing lender group.

For instance, where one lender in the group becomes the target of sanctions, the borrower may not be able to make the necessary payment in full to the agent in respect of a forthcoming debt repayment instalment. Given the inflexibility of loan documentation, such non-payment could nevertheless result in an ‘event of default’ in relation to the debt, allowing the lender group (as a whole) to exercise acceleration and enforcement rights. A waiver may not be technically possible without the intervention of the sanctioned lender.
In an extreme scenario, a borrower might take the view that no payment at all should be made to the agent in cases where there is a risk of breaching sanctions if some portion of that instalment might be paid forward to the sanctioned lender.
In another ‘sanctioned lender’ scenario, it is conceivable that payment from the borrower is not constrained by sanctions but that the facility agent (being in another jurisdiction) is itself prohibited from making onward payment to the sanctioned lender.
There is also the potential for sanctions to intervene between a lender of record and an entity (a participant) to whom the lender has entered into a contract to reduce its exposures under the loan (a ‘funded participation’ or ‘risk participation’). It may be difficult for the innocent party to exit the trade.

In such cases, there may be no easy solution within the framework of the existing contractual matrix. Accordingly, parties may wish to assess their exposure to such risks and take action to mitigate such risks, where possible, in existing contracts and when negotiating new transactions. The alternative is likely to be that parties may need to have recourse to the courts to resolve such issues, as in the selected case examples above.

Conclusion

There has been a relatively constant flow of financial sanctions-related cases through the English courts over the past couple of years as new disputes arise and existing cases are appealed, which is unlikely to slow in the short-term. The case law has demonstrated the inherent challenges of balancing contractual duties and considerations under English law against a varied and often conflicting set of regulatory obligations across multiple jurisdictions. Due to the nature of the business conducted by financial institutions, which will often involve a number of stakeholders and is typically cross-border, this is a particular challenge in the sector.

Given the potentially serious consequences of breaching sanctions but also of erring too far on the side of caution and being found to have acted unreasonably, it is vitally important for financial institutions to keep abreast of this case law and of new regulations that are implemented, to ensure that they make operational decisions which strike the correct balance between these two – sometimes conflicting – aims. This should include seeking legal advice on the potential applicability of sanctions across the various relevant jurisdictions prior to making commercial decisions relating to: (i) entry into international contractual arrangements which may involve entities from sanctioned jurisdictions; (ii) the exercise of rights and performance of obligations under those arrangements; and (iii) the termination of existing arrangements.